Is It Time to Temper Expectations for Yahoo! Inc. (YHOO)?

Yahoo! Inc. (YHOO)Just over 10 months ago, Marissa Mayer was brought in as CEO of Yahoo! Inc. (NASDAQ:YHOO). The hope was that she would be able to turn around a struggling company and restore it to profitability. Typically, investors tend to give the new CEO a year-long “honeymoon period” in which they might put the company in a good position going forward before taking a more circumspect and realistic view with regards to the company’s prospects.

Since Mayer’s debut, Yahoo! Inc. (NASDAQ:YHOO) shares have rallied nearly 70%. But now that we’re approaching the year mark, is it time to temper expectations for Yahoo!, or is it full steam ahead?

The Tumblr question

Yahoo! Inc. (NASDAQ:YHOO) recently purchased the social media site Tumblr for $1.1 billion, a move that has elicited mixed reactions. Although it may not be a cash cow, I believe that the move is essential to Mayer’s strategy going forward.

Her plan to restore profitability seems to be a three-part project: first, stop the company from hemorrhaging money; second, build a user base; and third, monetize that user base. She was able to stabilize the company, so phase one is almost complete.

The acquisition of Tumblr is the beginning of phase two. Mayer wants to develop a strong user base and start winning the page view battle with Facebook Inc (NASDAQ:FB) and Google Inc (NASDAQ:GOOG). Currently, Yahoo! Inc. (NASDAQ:YHOO) is losing viewers for the 13th straight month, and these viewers are going straight to Facebook Inc (NASDAQ:FB) and Google Inc (NASDAQ:GOOG). While Yahoo! is losing its audience, Facebook and Google are adding to theirs. Not only that, but Facebook and Google Inc (NASDAQ:GOOG) have already monetized their user bases, so they reap the benefit of the exodus from Yahoo!. Both Facebook and Google are projected to increase sales revenue by over 30% this year, and by between 15% and 25% next year.

Although Facebook Inc (NASDAQ:FB) only registers a 0.04% clickthrough rate on its advertisements, it is still able to post strong revenue growth thanks to a massive user base. Google’s success is due to a much higher clickthrough rate, near 8%, which means that it is earning revenue from around 8% of its users. For both of these companies, former Yahoo! viewers mean more revenue.

Likewise, the continued success of Yahoo! Inc. (NASDAQ:YHOO) is predicated on the establishment of a strong user base through Tumblr and possibly Hulu. However, after the “honeymoon period,” financial results start to speak for themselves. Yahoo! is only projected to increase revenue by 1.4% this year and 2.8% next year, even with the acquisition of Tumblr.

What’s the next step?

Mayer needs to monetize Tumblr, and fast. Her strategy seems to revolve around building Yahoo! as a brand and hoping that Tumblr enthusiasts become acquainted with Yahoo!’s other sites. However, this isn’t a strategy that has worked for Yahoo! in the past. In general, consumers surf the sites that they like best, regardless of ownership.

Assuming Mayer comes to that realization, she is then given the challenge of monetizing Tumblr, which is difficult, if not impossible. It is first and foremost a blogging site, driven by user pages. What this means is that it’s easy for Mayer to sell advertising on (assuming she does so without alienating users) but it’s much more difficult for her to sell advertising on Even Mayer herself admits that she’s not sure how the $1.1 billion investment will generate a suitable return.

Foolish conclusions

The acquisition of Tumblr does reflect recognition of Yahoo! Inc. (NASDAQ:YHOO)’s bid for relevance—before Mayer, start-ups shied away from Yahoo!. However, it’s not going to turn the company around. It’s too hard to monetize, and its user base is unlikely to become loyal to other Yahoo! sites.

If Yahoo! is able to acquire Hulu, that would be a huge step toward success. Hulu would give Yahoo! another large user base, and most importantly it is already monetized. Yahoo! needs to start showing rapid growth both in audience and revenue if it wants to compete with Facebook and Google. After a year atop the company, Mayer will soon be held to the same standards as other executives in the industry.

There’s pressure to perform—Mayer knows this—and if she can figure out a way to monetize her user base she’ll be able to meet expectations. An energized culture at Yahoo! Inc. (NASDAQ:YHOO) is a huge upside, and could carry the company to new heights. There’s a strong potential for increases in share price, but at the same time there’s a lot of risk. It could skyrocket, or it could tank—that’s all dependent upon how much revenue Mayer can bring in and how large a user base she can convert.

The article Is It Time to Temper Expectations for Yahoo!? originally appeared on and is written by Hunter Hillman.

Hunter Hillman has no position in any stocks mentioned. The Motley Fool recommends Facebook and Google. The Motley Fool owns shares of Facebook and Google. Hunter is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

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